Little Britain Goes It Alone

But on the day of my departure, conversations were dominated by events in another country — the United Kingdom.

The next day, voters were scheduled to decide whether to leave the European Union.

My Swiss friends were utterly convinced that the vote would be “no.”

But as we all know now, a narrow majority of U.K. citizens voted to leave the European Union.

No matter what one may feel about Brexit’s merits, there’s no doubt that the consequences will be severe and far-reaching.

A Sterling Opportunity

Two of those consequences present an opportunity for profit.

First, if the U.K. leaves the European Union without a new trade deal, the pound will collapse.

Normally, markets would have “priced in” Brexit already. But ongoing uncertainty means the pound has been trading in a narrow band up to now.

Currency traders are waiting for clarity. But if a no-deal Brexit becomes likely, they will pounce. The pound sterling will collapse.

Second, most of the U.K.’s leading companies earn most of their profits outside the country.

If the pound falls, that will increase the sterling value of their overseas earnings and bolster their share price as reckoned in pounds.

Say the pound depreciates 20% against the euro. By virtue of that fact alone, £1 worth of British corporate earnings in the euro zone will become £1.20.

Higher Earnings … but Cheaper Assets

The currency effects of Brexit don’t end there.

Because the pound will have depreciated after Brexit, British equities will become cheaper in dollar terms.

If the pound depreciates by 20% against the dollar, a British company that sells for £1 today could end up costing only £0.80 in the days after a no-deal Brexit.

On top of that, British equities have been cheap for a while now.

A recent survey of global fund managers by Bank of America Merrill Lynch showed that investors are more negative toward the London market than at any time in the past two decades.

Consequently, the FTSE 100 Index yields 4.6% and trades on a historic price-to-earnings ratio of 11.5. That makes it extraordinarily cheap by historical standards — and definitely by U.S. standards.

Take the Long View

To summarize: A no-deal Brexit will increase the pound sterling value of British companies’ offshore earnings. That will tend to increase their share price.

But in the days after Brexit, the weak pound will make those companies extraordinarily cheap in U.S. dollar terms.

The pound will ultimately regain much of its value. It may take a few years, but eventually the pound will appreciate against the dollar.

As the pound increases in value, the U.S. dollar value of British companies’ stock price and earnings will increase as well. That currency effect will be on top of any real increase in price and earnings.

That creates a unique opportunity:

Buy British equities when they are at their cheapest in dollar terms.

Hold on to those stocks until the pound recovers.

Reap the combined benefits of price appreciation and dividends and the currency effects of the stronger pound.

In other words, let Brexit turbocharge your U.S. dollar wealth and earnings.

Right now, EWU is trading around $32 a share. But if a no-deal Brexit comes to pass, it could drop to half that price. That’s when you buy shares.

A 50% drop would make EWU one of the hottest bets you can make this year.

Once the Brexit dust settles, the interplay of currencies will set you up for a great payoff.

Kind regards,

Ted Bauman

Editor, The Bauman Letter

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Disclaimer
Nothing herein should be considered personalized investment advice. The advice we provide is published generally, is not personal to you and does not take account of your personal circumstances. You should not base investment decisions solely on this document.